FLSA FAQ: The Problem with Per Diems

Last week, I mentioned that the “per diem” issue under the Fair Labor Standards Act (FLSA) is not just a regular rate calculation problem, but a liability issue, too. In the case that we discussed on Friday, the parties had agreed that the per diem payment the worker received was a reasonable approximation of his expenses when he deployed to remote job sites. That is the somewhat unusual case, though. This summer, the Department of Labor scored nearly $3.5 million in back wages for more than 3,000 oil field service workers. As part of an ongoing investigation into what the DOL has called a “pervasive” practice to avoid overtime and payroll taxes, investigators found that welders, electricians, pipe fitters, and other craft workers hired by staffing firms to work on maritime vessels and oil and gas projects along the Gulf Coast are often paid “per diems” as part of their wage packages that do not correlate to those employees’ actual expenses. Here, the DOL found employers on the other end of the spectrum–paying per diems when employees incurred no expenses at all.

The Per Diem Problem

As you undoubtedly know, employer must pay all non-exempt employees who work more than 40 hours in a workweek overtime wages of one and one-half times their “regular rate” of pay. 29 U.S.C. § 207(a)(1). That seems simple–an employee who makes $15/hour must earn $22.50/hour when working overtime. However, I put “regular rate” in quotes because the FLSA defines it much more broadly. Section 207(e) requires employers to include “all remuneration for employment” in the regular rate, not just the base hourly wage (save for a few exceptions, like gifts, capital gains on stock options, or bona fide profit sharing payments). Importantly, employers may only exclude per diem payments made for “reasonable payments for travel expenses, or other expenses, incurred by an employee in the furtherance of his employer’s interests and properly reimbursable by the employer.” 29 U.S.C. § 207(e)(2). The regulations further explain that reimbursements are only “reasonable” if they “reasonably approximate” the employee’s work-related expenses (29 C.F.R. § 778.216(a), (b)(3), (c)). For many employers, this is easy: the employee turns in a receipt for an expense, and the employer reimburses it in that exact amount. This kind of reimbursement is almost always excluded from the regular rate calculation.

However, this creates a substantial amount of paperwork, auditing responsibilities, and recordkeeping. For some employers, it is easier to reimburse employees at a flat rate, either by the hour or the day. Hours-based per diem payments are just another form of remuneration. You cannot exclude those. Expenses by the day are far more common. Under this approach, employers pay a “per diem” for expenses based on a flat rate each day for some or all of the employee’s expenses, regardless of whether the employee actually incurs them. These payments might not be excludable, either, though many employers assume that they are. In the article linked above, the DOL’s spokesman indicated that the employers responded that the per diem payments were an industry standard practice. Unfortunately, “everybody’s doing it” is no better a defense now than it was with your parents.

How Non-Excludable Per Diems Affect the FLSA’s “Regular Rate” Calculation

As with many wage and hour miscalculations, failing to add non-excludable per diem payments to the regular rate can create massive liability very quickly. Take the example above of an employee making $15 per hour. Let’s assume that the employer pays the employee $75 day as a per diem for meals ($375/week). If this non-exempt employee works 50 hours per week (10 hours of overtime), the pay calculation looks like this:

(50 hrs. × $15/hour) = $750 in straight time pay

($15 ÷ 2) × 10 overtime hours = $75 for the overtime premium

Without considering the per diem, the employer owed $825 to the employee each week.

However, in the DOL’s investigation linked above, the non-exempt employee never actually incurred any expenses (or, more commonly, incurs substantially fewer). In this case, the DOL would treat the per diem as remuneration that must be included in the regular rate pursuant to the FLSA regulations. Now, the employee’s $15 per hour straight-time rate then becomes $20 per hour:

(50 hrs. × $15/hour) + ($375 per diem) = $1,125

($1,125 ÷ 50 hrs.) = $22.50 per hour

Ouch! The per diem reimbursement increased the rate by 50%. Instead of $75 for overtime, the employer owes $112.50 each week (($22.50 ÷ 2) × 10 overtime hours = $112.50). The employer hasn’t paid tax witholdings on the difference, either. That’s another 12% that the IRS and state taxing agencies can seek on top of the FLSA violations. A $112.50 per week shortage adds up quickly: $5,850 per employee, per year…plus another $5,850 for liquidated damages…plus your employees’ attorney’s fees…plus civil fines from the DOL…plus tax penalties and interest—all for this very simple example.

Upshot for Employers

The per diem issue is a focus for the DOL, as evidenced by their reference to it as a “pervasive practice.” Expect great scrutiny on even the close cases, and expect that the DOL will report their findings to the IRS and state tax collectors for investigation, too. The DOL, the IRS, and many state tax authorities have information sharing agreements in place that means an FLSA problem can become a tax problem, and vice versa. Of course, part of the DOL’s mission in publicizing their recoveries is to raise employees’ awareness of their rights, too. Employers who get sloppy with per diem payments can wind up facing private lawsuits from employees.

Tomorrow, I’ll share an approach to per diem payments that has the benefit of being both simple and more easily defensible than grabbing a daily rate out of thin air or trying to manage mile-high piles of receipts.

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